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www.charlestonmarketreport.com “The pessimist complains about the wind; the optimist expects it to change; the realist

www.charlestonmarketreport.com

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” William Arthur Ward

October 2009 Edition In This Issue:

RESILIENT Charleston Cartoons Slow Recovery Bank Failures Commercial Real Estate in Charleston Trick or Treat? Just Desserts and Markets Being Silly Again Charleston Snapshot Real Estate Tidbits National Economic/Housing Trends and 5 Year Forecast

Quick Note: I previously announced I would not use MLS data anymore. I have changed my mind and the next issue I will do some residential Charleston real estate analysis as long as CTAR allows me to have access to the MLS again. I am not sure if they will but I am going to try. From my past experiences CTAR does not like my analysis because it does not always paint a rosy and optimistic view of the market. Now, when I mention CTAR I have to stress that this organization has its rules made the realtors in Charleston. So we will see what happens and time will tell if I get access again. There are many realtors that subscribe to the CMR and want the truth out in the open in the market however they are outnumbered by some agents who use “smoke and mirrors” just to make a commission. This occurs in all businesses that are driven by commissions and just a fact of life.

Resilient Charleston Since I was born and raised in Charleston I feel I know this town pretty darn good from many different perspectives. I have lived here almost my entire life except for that first job out of college which took me to Charlotte and New York for a couple of years. There is one word that comes to my mind about Charleston which

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history will prove time and time again…

of Charleston always seem to find a way to come back strong. This was displayed during the Civil War, a major earthquake in 1886, numerous hurricanes but especially Hugo in 1989, the closing of the Navy Base and the present severe recession that has caused high unemployment and multiple challenges in the real estate industry.

RESILIENT.

Whenever you think this city is on the rocks the citizens

However, the past few weeks have given lifelong and current Low country residents a reason to smile with the announcement of the signing of a new Maersk contract that will keep the shipping company from leaving the Port of Charleston and the announcement last week of the commitment from Boeing to build a production plant to build the 787 Dreamliner in North Charleston.

The impact from Boeing coming to Charleston is all positive for the local Tri County economy. The question that is impossible to answer at the moment is what type of economic impact Boeing will have on the Tri County economy? Boeing will not cure all the real estate and unemployment problems in Charleston but it will certainly help once the plant begins operations. Charleston is quietly building some “cluster” industries that could have a significant impact in the future with Boeing and the Defense industry. Both industries bring good paying jobs with nice benefits that will help this economy. However, the impact of Boeing will take time. The plant will take approximately two years to build so do not plan on an instant influx of homebuyers yet.

Here is the exciting aspect of this entire deal. Boeing employs 76,000 people in the state of Washington and there are 150,000 jobs associated with Boeing in Washington. It is very possible that the 3800 jobs to be filled in North Charleston is just the beginning of many more to come. Now if we get 25-50% of these current jobs in Washington shifted to Charleston then it will be a major game changer for this market in the next five to ten years. It will change everything from unemployment rates to the real estate market BUT as of right now nobody knows what Boeing plans on doing. I know one thing that they are sick and tired of the Machinist Union and can not afford anymore plant shutdowns. I have a feeling the 787 plant is just the beginning of many more jobs to come because SC is a right to work state with a world class port and affordable lifestyle. Time will tell.

Cartoons

to come because SC is a right to work state with a world class port and

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Slow Recovery

One reason for this has been a gradual shift over the past decade in how employers view the economy. Recessions were once viewed as a temporary phenomenon in which workers were more easily laid-off and then re-hired once business activity picked up. While recessions are still temporary, the effect they have on the job market has tended to linger over a longer period. In an increasingly competitive and specialized environment, employers have become less willing to part with highly skilled workers who can be costly to replace once the market turns the corner. The approach many employers took during the 2001 recession, consequently, was a strategic one in which they pared payrolls by eliminating redundancy and increased efficiency by retaining only the most productive workers. In this way employers were able to increase worker productivity and eliminate the need to rapidly replenish their payrolls during the subsequent recovery.

Structural Imbalances in Finance and Housing Present Challenges to Real Estate

in Finance and Housing Present Challenges to Real Estate Source: Bureau of Labor Statistics. The longtime

Source: Bureau of Labor Statistics.

The longtime readers of the CMR knew a long time ago that this was not going to be an ordinary recession. In fact it's hard to envision a situation where one could argue that either finance or housing could rebound quickly enough to power an economic recovery. Jobs lost on Wall Street are likely permanent; losses in securities and trading as a result of mergers, acquisitions and outright failures will likely never be replaced, as these types of actions are geared at eliminating redundancies. If that were not enough, banks are now bracing for the fallout of a potential commercial real estate collapse. As asset values have fallen sharply over the past two years, many banks are holding commercial loans on properties that are now worth less than their outstanding debt—a predicament that is drawing some parallels in the press to the sub prime housing crisis.

Make no mistake, however: the recovery will take some time. It's hard to image a scenario in which the job market could bounce back in such a way that commercial real estate fundamentals might quickly turn around. The bottom is coming into sight, but we will be slow to return to the pre-crisis glory days.

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Bank Failures The increase in bank failures has been expected especially as the commercial real estate market weakens. Let the good banks survive and the bad banks fail is the way the free market should work. Unfortunately the U.S. has a few big banks that are “Too big to fail” that control the majority of the loans in the U.S. It should also be noted that the FDIC is probably controlling the number of banks that fail each Friday to keep a panic from occurring. Obviously from the graph below we are beginning to see more action on “Failure Friday.” Get used to it for the next few years unless we have more stimulus laws passed to bailout other banks.

From Bud Conrad of Casey Research:

“We should be closing several hundred banks almost immediately. The problem is that the FDIC is out of money. So they are just kicking the can down the road and ignoring many problems. The result of that is that the banks get into even worse trouble every day. You see, the law is that the FDIC is supposed to promptly close any institution that doesn't meet its capital requirements. If it does so, it wipes out the shareholders, but normally there is some equity left in the operation, and the cost to refund the depositors is very small.

But by letting the banks hang on, they lose more and more every day, to the point that when they are closed down, the net negative difference between assets and liabilities is a big loss, and then, when the FDIC does close them down, there are huge losses to be made up. Even in this case, the FDIC has done a deal to kick the can down the road by giving the carcass to USB and letting them figure out later how bad the losses have actually become.

The FDIC says this bailout will cost $2.5 billion. I'm willing to bet that they are hiding losses just as they've been avoiding taking over banks until it's far too late. The combination is that they've built up a reservoir of big losses that they in no way can handle. The whole organization has been mismanaged from top to bottom since the beginning, when Paulson was telling Sheila Bair what to do. She was supposed to be running the tight ship of an insurance company, and she became part of the government scam.

Furthermore, the FDIC has guaranteed debts of over $300 billion by the big banks, lowering their interest rate on that debt so that the profits accrue more rapidly on the investments. The FDIC has no business doing such operations.

Perhaps the worst line in Sheila Bair's interview here is her saying that the public has absolutely no reason to be scared that their deposits would not be covered. Her glib talking over interviewers very fast and acting confident reminds me of Geithner. They are driving all of us over the cliff.”

Since I deal with banks everyday I can tell all of you that this quote from Mr. Conrad is correct. Part of the reason the FDIC does not want to shut down to many banks each Friday is that they do not want to spook the market and cause a run on the banks. The FDIC is very calculated in the number of banks they are shutting down each week so I do not expect to ever see 30 banks shutdown in one day or it would be all over the news and cause the American consumer to get really scared. I still stick by my prediction that over 1000 banks will fail before the dust settles because the commercial real estate market is going to get worse due to the future resets. If the FDIC and the government allow too many banks to collapse all at once then we will enter a Great Depression scenario which is exactly what nobody wants to have happen.

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Commercial Real Estate in Charleston The real wild card for the economy in many experts’

Commercial Real Estate in Charleston The real wild card for the economy in many experts’ opinions remains the fate of the commercial real estate market. A large amount of commercial notes are coming due in the next three years while vacancy rates are climbing and refinancing becomes more difficult in deteriorating economic conditions. Since the securitization of loans for CRE is dead it has become very difficult to get new deals done in the current market.

In my opinion, www.barkleyfraser.com has the best commercial real estate reports for the Charleston area. You will all notice below that the vacancy rates in some specific areas for industrial and office markets are extremely high. This is the result of a commercial market that has become overbuilt just like certain areas of the residential market. If you have cash and want to be an owner occupier of commercial property there are some major discounts to be had compared to the market top prices we all witnessed in 2007. Yes, blood is running through the commercial streets but this is the normal process that must occur as a market goes through a major correction towards a bottom.

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Industrial Notes • TBC announced Berkeley County for a 1.1 mil sq ft distribution facility.

Industrial Notes

TBC announced Berkeley County for a 1.1 mil sq ft distribution facility.

Boeing announced they were building an assembly line for the 737 Dreamliner, which means more announcements are possible in the future for other planes.

The former Mikasa DC may be purchased.

Sales remain slow and space is being offered 40% below the market highs of 2007.

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Office Notes • The vacancy trend has leveled out; however it has leveled out at

Office Notes

The vacancy trend has leveled out; however it has leveled out at 21%.

The sales market is dominated by distressed sales and foreclosures which is causing declining prices.

Demand for vacant office land is very soft and prices are falling.

Demand for vacant space is still soft resulting in downward pressure on lease rates.

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Retail Notes • The retail market remains stable. This is stunning considering what has happened

Retail Notes

The retail market remains stable. This is stunning considering what has happened over the course of the past year.

Leasing activity has remained surprisingly strong despite negative economic news.

Expect leasing activity to cool off the next few quarters until confidence returns to the economy.

Source: www.barkleyfraser.com

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Trick or Treat?

Trick or Treat? Trick….Bernie Madoff for Halloween. Whatch out he might have stolen candy from you!

Trick….Bernie Madoff for Halloween. Whatch out he might have stolen candy from you!

The paper below written by Jeremy Grantham is so good I just had to copy and paste it into the CMR. Grantham is a financial genius on risk and the markets.

Just Desserts and Markets Being Silly Again By Jeremy Grantham

Just Desserts

I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just desserts? Let’s review some of the more obvious examples.

1. For Missing the Unmissable

Bernanke, the most passionate cheerleader of Greenspan’s follies, is picked as his replacement, partly, it seems, for his belief that U.S. house prices would never decline and that at their peak in late 2005 they largely just reflected the unusual strength of the U.S. economy. As well as missing on his very own this 3-sigma (100-year) event in housing, he was completely clueless as to the potential disastrous interactions among lower house prices, new opaque financial instruments, heroically increased mortgages, lower lending standards, and internationally networked distribution. For these accumulated benefits to society, he was reappointed! So, yes, after the fashion of his mentor, he was lavish with help as the bubble burst. And how can we so quickly forget the very painful consequences of the previous lavishing after the 2000 bubble? Rewarding Bernanke is like reappointing the Titanic’s captain for facilitating an orderly disembarkation of the sinking ship (let’s pretend that happened) while ignoring the fact that he had charged recklessly through dark and dangerous waters.

2. The Other Teflon Men

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Larry Summers, with a Financial Times bully pulpit, had done little bullying and blown no warning whistles of impending doom back in 2006 and 2007. And, famously, in earlier years as Treasury Secretary he had encouraged (I hope inadvertently) wild and reckless financial behavior by helping to beat back attempts to regulate some of the new and most dangerous instruments. Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks. And there are several others (discussed in the 4Q 2008 Letter). You know who you are. All promoted!

3. Misguided, Sometimes Idiotic Mortgage Borrowers

The more misguided or reckless the borrowers, the more determined the efforts to help them out, it appears, although it must be admitted these efforts had limited effect. In comparison, those who showed restraint and either under housed themselves or rented received not even a hint of help. Quite the reverse: the money the more prudent potential buyers held back from housing received an artificially low rate. In effect, the prudent are subsidizing the very same banks that insisted on dancing off the cliff into Uncle Sam’s arms or, rather, the arms of the taxpayers – many of whom rent.

4. Reckless Homebuilders

Having magnificently overbuilt for several years by any normal relationship to the population, we have decided to encourage even more homebuilding by giving new house buyers $8,000 each. This cash comes partly from the pockets of prudent renters once again. This gift is soon, perhaps, to be extended beyond first-time buyers (for whom everyone with a heart has a slight sympathy) to any buyers, which would be blatant vote-buying by Congress. So what else is new?

5. Over-spenders and Under-savers

To celebrate the overwhelming consensus among economists that U.S. individuals have been dangerously over consuming for the last 15 years, we have decided to encourage consumption and penalize savers by maintaining the aforementioned artificially low rates, which beg everyone and sundry to borrow even more. The total debt to GDP ratio, which under our heroes Greenspan and Bernanke rose from 1.25x GDP to 3.25x (without even counting our Social Security and Medicare commitments), has continued to climb as growing government debt more than offsets falling consumer debt. Where, one wonders, does this end, and with how much grief?

6. Banks Too Big to Fail

Here we have adopted a particularly simple and comprehensible policy: make them bigger! Indeed, force them to be bigger. And whatever you do, don’t have any serious Congressional conversation about breaking them up. (Leave that to a few journalists and commentators. Only pinkos read pink newspapers anyway!) This is not the first time that a cliché has triumphed. This one is: “You can’t roll back the clock.” (See this quarter’s Special Topic: Lesson Not Learned: On Redesigning Our Current Financial System.)

7. Over-bonused Financial Types

Just look at Goldman’s recent huge “profits,” two-thirds of which went for bonuses. It is now estimated that this year’s bonus pool will be plus or minus $23 billion, the largest ever. Less than a year ago, these same guys were on the edge of a run on the bank. They were saved only by “government” – the taxpayers’ supposed agents – who decided to interfere with the formerly infallible workings of capitalism. Just as remarkably, it is now reported that remuneration for the entire banking industry may be approaching a new peak. “Well, we got rid of some of those pesky competitors, so now we can really make hay,” you can almost hear Goldman and the others say. And as for the industry’s concern about the widespread public dismay, even disgust, about excessive remuneration (and, I would add, plundering of the shareholders’ rightful profits)? Fuhgeddaboudit! In the thin book of “lessons learned,” this one, like most of our other examples, will not appear.

8. Overpaid Large Company CEOs

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Even outside the financial system, there are many painfully obvious unjust desserts in the form of top management rewards. And most of the excessive rewards come out of the pockets of our clients and other stockholders, which is particularly galling. When I arrived in the States in 1964, the ratio of CEO pay to the average worker was variously reported to be between 20/1 and 40/1. This seemed perfectly respectable and had held for the previous 30 years. By 2006, this ratio had exploded to between 400/1 and 600/1, which can only be described as obscene. The results certainly don’t suggest such high rewards: a) 10-year stock market returns are close to zero in real terms; and b) U.S. GDP growth has finally slipped below its 100-year trend of 3.5%. After deducting the effect of the rampant increase in the financial system, the growth in GDP ex-finance has fallen to 3.1% since 1982 and well below 3% since 2000, all measured to the end of 2007 to avoid the recent crisis. The corporate system, to be frank, seemed to run faster and more efficiently back in the 1960s before CEOs and financial types began to gobble up other people’s lunches. I suppose I have done my share of gobbling. But, it still ain’t right!

9. Holders of the Stocks of Ridiculously Overleveraged and Wounded Corporations Yes, I admit this is part envy and part hindsight investment regret. But, really, our financial leaders so over stimulated the risk-taking environment that junky, weak, marginal companies and zombie banks produced a record out performance (the best since 1933) of junk over the great blue chips. (Ouch!) In a world with less moral hazard, which would be a world of just, although painful desserts, scores of these should-be-dead companies would be. As it is, they live to compete against the companies that actually deserve to be survivors. Excessive bailouts are just not healthy for the long-term well-being of the economy.

10. The Well-managed U.S. Auto Industry

While firms in other industries fail and their workers look for new jobs, the auto industry is rewarded by direct subsidized loans, governmental arm-twisting of creditors forced to settle far below their legal rights, and direct subsidies for their products. All of this for their well-deserved ranking as the most short-sighted industry of the last 20 (40?) years, and one of the worst managed.

11. The World’s Most Over-vehicled Country

We chew up a dangerously large amount of Middle Eastern oil (and oil desperately squeezed from Canadian tar sands), which is ruinous for our globalpolitical well-being (and ability to avoid war) and also not so good for an overheating world. So the answer must be to subsidize more car purchases, and when the subsidies run out, you can have all the fun again. Good long-term thinking!

12. Stock Options

This, of course, is the crème de la crème of unjust desserts. Recent practices have basically been a legalized way to abscond with the stockholders’ equity. So if the stock price crashes, perhaps with considerable help from management, that’s all right – just rewrite the options at the new low prices. There has been no serious attempt to match stock option rewards (or total financial rewards for that matter) to the building of long-term franchise value. Instead, the motto is: grab it now and run! You can fill in your own favorite anecdotes here – there are so many of them!

13. Finally, Just in Case You’ve Forgotten, We Have My Old Nemesis, Greenspan

Alan Greenspan receives the title of Maestro in the U.S. and is knighted by the Queen for thoroughly demolishing the integrity of the U.S. financial system. He overtly ignored the great threat of bubbles in asset classes and, in fact, encouraged them. He Ayn Rand-ishly facilitated the progressive dismantling of governmental restrictions on financial behavior; he deliberately kept real interest rates at zero for years, etc., etc., etc. You have heard it before. Now, remarkably, in his very old age he has become imbued with the spirit of Hyman Minsky:

“Unless somebody can find a way to change human nature, we will have more crises.” Now he finally gets it. Too late! In his merely old age, he ignored or abhorred Minsky, and consistently behaved as though markets were

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efficient and the players were honest and sensible at all times. But for all of the egg on his face, the Maestro continues to consult with the rich and famous, considerably to his financial advantage. In the good old days, he would have been set in the village stocks, and not the kind you buy and sell. And I would have been right there, Alan, with very ripe tomatoes.

The Last Hurrah and Markets Being Silly Again The idea behind my forecast six months ago was that regardless of the fundamentals, there would be a sharp rally. 1 After a very large decline and a period of somewhat blind panic, it is simply the nature of the beast. Exhibit 1 shows my favorite example of a last hurrah after the first leg of the 1929 crash.

of a last hurrah after the first leg of the 1929 crash. After the sharp decline

After the sharp decline in the fall of 1929, the S&P 500 rallied 46% from its low in November to the rally high of April 12, 1930. It then, of course, fell by over 80%. But on April 12 it was once again overpriced; it was down only 18% from its peak and was back to the level of June 1929. But what a difference there was in the outlook between June 1929 and April 1930! In June, the economic outlook was a candidate for the brightest in history with effectively no unemployment, 5% productivity, and over 16% year-over-year gain in industrial output. By April 1930, unemployment had doubled and industrial production had dropped from +16% to -9% in 5 months, which may be the world record in economic deterioration. Worse, in 1930 there was no extra liquidity flowing around and absolutely no moral hazard. “Liquidate the labor, liquidate the stocks, liquidate the farmers” 2 was their version. Yet the market rose 46%.

How could it do this in the face of a world going to hell? My theory is that the market always displayed a belief in a type of primitive market efficiency decades before the academics took it up. It is a belief that if the market once sold much higher, it must mean something. And in the case of 1930, hadn’t Irving Fisher, arguably the greatest American economist of the century, said that the 1929 highs were completely justified and that it was the decline that was hysterical pessimism? Hadn’t E.L. Smith also explained in his Common Stocks as Long Term Investments (1924) – a startling precursor to Jeremy Siegel’s dangerous book Stocks for the Long Run (1994) – that stocks would always beat bonds by divine right? And there is always someone of the “Dow 36,000″ persuasion higher prices in previous peaks must surely have meant something, and not merely have been unjustified bubbly bursts of enthusiasm and momentum.

Today there has been so much more varied encouragement for a rally than existed in 1930. The higher prices preceding this crash (that were far above both trend and fair value) had lasted for many years; from 1996 through 2001 and from 2003 through mid-2008. This time, we also saw history’s greatest stimulus program, desperate

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bailouts, and clear promises of years of low rates. As mentioned six months ago, in the third year of the Presidential Cycle, a tiny fraction of the current level of moral hazard and easy money has done its typically great job of driving equity markets and speculation higher. In total, therefore, it should be no surprise to historians that this rally has handsomely beaten 46%, and would probably have done so whether the actual economic recovery was deemed a pleasant surprise or not. Looking at previous “last hurrahs,” it should also have been expected that any rally this time would be tilted toward risk-taking and, the more stimulus and moral hazard, the bigger the tilt. I must say, though, that I never expected such an extreme tilt to risk-taking: it’s practically a cliff! Never mess with the Fed, I guess. Although, looking at the record, these dramatic short-term resuscitations do seem to breed severe problems down the road. So, probably, we will continue to live in exciting times, which is not all bad in our business.

Lesson Not Learned: On Redesigning Our Current Financial System I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship’s construction, of the company’s policy, or of the captain’s competence. “No one could have seen this coming,” would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises.

After a crisis, if you don’t want to waste time on palliatives, you must begin with an open and frank admission of failure. The Titanic, for example, was just too big and therefore too complicated for the affordable technology of its day. Given White Star Line’s unwillingness to spend, she was under-designed. The ship also suffered from agency problems: the passengers bore the risk of unnecessary speed and overconfidence in “too big to sink!” while the captain stood to be rewarded for breaking the speed record. No captain is ever rewarded for merely delivering his passengers alive. Greenspan, nearly 100 years later in his short-lived “irrational exuberance” phase, did not enjoy being metaphysically slapped by the Senate Subcommittee for threatening the then speedy progress of the economy. What is needed in this typical type of agency problem is for the agent on those rare occasions when it really matters, whether a ship’s captain or a Fed boss, to stop boot licking and say, “No, this is wrong. It is just too risky. I won’t go along.”

We have an once-in-a-lifetime opportunity to effect genuine change given that the general public is disgusted with the financial system and none too pleased with Congress. I have no idea why the current administration, which came in on a promise of change, for heaven’s sake, is so determined to protect the status quo of the financial system at the expense of already weary taxpayers who are promised only somewhat better lifeboats. It is obvious to most that there was a more or less complete failure of our private financial system and its public overseers. The regulatory leaders in particular were all far too captured and cozy in their dealings with reckless and greedy financial enterprises. Congress also failed in its role. For example, it did not rise to the occasion to limit the recklessness of Fannie and Freddie. Nor did it encourage the regulation of new financial instruments. Quite the reverse, as exemplified by the sorry tale of CFTC Chairman Brooksley Born’s fight to regulate credit default swaps.

But, at least now, Congress seems to realize the problem: the current financial system is too large and complicated for the ordinary people attempting to control it. Even Barney Frank, were he on his death bed, might admit this; and most members of Congress know that they hardly understand the financial system at all. Many of the banks individually are both too big and so complicated that none of their own bosses clearly understand their own complexity and risk taking. The recent boom and the ensuing crisis are a wonderfully scientific experiment with definitive results that we are all trying to ignore. And, except for bankers, who have Congress in an iron

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grip, we all want and need a profound change. We all want smaller, simpler banks that are not too big to fail. And we can and should arrange it!

Step 1 should be to ban or spin off that part of the trading of the bank’s own money that has become an aggressive hedge fund. Proprietary trading by banks has become by degrees over recent years an egregious conflict of interest with their clients. Most if not all banks that prop trade now gather information from their institutional clients and exploit it. In complete contrast, 30 years ago, Goldman Sachs, for example, would never, ever have traded against its clients. How quaint that scrupulousness now seems. Indeed, from, say, 1935 to 1980, any banker who suggested such behavior would have been fired as both unprincipled and a threat to the partners’ money. I, for one, saw Goldman in my early days as a surprisingly ethical firm, at worst “long-term greedy.” (This steady loss of the old partnership ethic is typically underplayed in descriptions of Goldman.) Today, Goldman represents a potential hedge fund trade as being attractive precisely because they themselves have already chosen to do it. These days, all – or almost all – large banks do proprietary trading that is pure hedge fund in nature. Indeed the largest bank, Citi (owned by us taxpayers), is gearing up to substantially increase its aggressive prop trading as I write. (”No, no, we’re not!”)

Some insiders have argued that we should not worry about prop trading because they claim it did not play an important part in the recent crisis. I think this is completely wrong for it misses the very big picture. Prop trading can easily introduce an aggressive hedge-fund type mentality into the very hearts of what ideally should be conservative, prudent – even boring – banks. This hedge fund mentality became a dominant organizing principle, particularly with respect to compensation practices. It encouraged personal aspirations over corporate goals and invited bonus-directed behavior at the clients’ expense and ultimately, as we have seen, at the taxpayers’ expense to rid itself of this problem. All Congress has to overcome is the lobbying power and campaign contributions of the finance industry itself, which I admit is no small feat. In a bank with a hedge fund heart, you can’t reasonably expect ethical or non-greedy behavior, and you haven’t seen it.

Of course, commercial and investment banks need to invest their own capital. They probably should have the right to do genuine hedging against investments that flow naturally from their banking business. As for the rest, they could easily be required either to limit the leverage used on prop desk trading or to be restricted to investing in government paper and, at the very least, play by the same rules as other hedge funds. What they certainly should insurance, as is now the case.

In the early 1930s, following the famous Pecora hearings, the conflict of interest between the management of other people’s money as fiduciary and the business of dealing and underwriting in securities was considered so inimical to the public interest that Congress almost compelled separation of proprietary trading and client trading. Close, but no cigar. Instead, Glass-Steagall made the probably less useful step of separating commercial and investment banking. Unfortunately, they left intact the obvious conflict between the banks’ managing their own money and simultaneously that of their clients. We now have a unique opportunity to revisit this matter. (As we ponder the problem of prop trading, let us consider Goldman’s stunning $3 billion second quarter profit. It appeared to be almost all hedge fund trading. Be aware also that this $3 billion is net of about $6 billion reserved for future bonuses. Goldman’s CEO had, in fact, the interesting job of deciding how much of this $9 billion profit would be arbitrarily awarded to shareholders. [In this case, one-third. Could be worse!] This means that they extracted every penny of $9 billion from a fragile financial system. “Good for them,” you may say, and they indeed are very smart. But surely they should not have been insured against failure by us taxpayers! Remember, they are now also a commercial bank yet very, very little of their $9 billion came from making loans. Three months later their bonus pool for the year is estimated to be a new record at $29 billion. And the whole banking industry is back to a new record for remuneration. How resilient! How remarkable! How basically undesirable for our economy!)

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In Step 2, the Justice Department, together with Congressional and other advisors, should be invited to develop a special set of rules for the banking industry that recognizes the moral hazard of “too big to fail.” If really too big to fail, banks should be divided by Justice into manageable, smaller pieces that can indeed be allowed to fail. With these two steps and possibly with an intelligent son of Glass-Steagall, the deed would be done! Regulators would have a fighting chance of being able to regulate, unlike their recent woeful past. If an angel appeared, waved his wings and, lo, it was so, almost every single Congressman would sigh with relief.

The separation of commercial banking from investment banking is not as vital as the removal of prop desk complicated enterprises both smaller and simpler, which characteristics I for one believe are probably essential if we are to avoid further disasters. So what is the problem? The argument against all major changes, without at least some of which we will soon surely be back in another crisis, is always the same. “Oh, you can’t roll back the clock.” But, even repeated twice before every breakfast, it is not persuasive. Why exactly can’t you roll back the clock? We did it once before and, although it was very imperfect and probably missed the central point of conflict of interest, it still produced an improved system that was successful enough for 50 years. In general, countries with simpler and less aggressive banks have had much less pain in the recent crisis while we were pawning the Crown Jewels – sorry, the Federal Jewels – to bail out aggressive bankers who were out of their depth in the new complexities.

Step by step, even as the complexity grew, our regulatory leaders enabled systemic risk to grow. They continued to push the boundaries for banks by allowing more leverage, new instruments, and less control. The details are familiar. All this was done in the name of untrammeled, unfettered capitalism, and almost all of it was a bad idea. “Oh!” say the bankers, “If we become smaller and simpler and more regulated, the world will end and all serious banking will go to London, Switzerland, Bali Hai, or wherever.” Well, good for those other places. If that means they will have knee-buckling, economy cracking, taxpayer-impoverishing meltdowns every 15 years and we will be left looking like a boring back water, that sounds fine to me. Remember, just like our investment management branch of the financial system, banking creates nothing of itself. It merely facilitates the functioning of the real world.

Yes, of course every country needs a basic financial system to function effectively with letters of credit, deposits, and check writing facilities, etc. But as you move beyond that it is worth remembering that every valued job created by financial complexity is paid for by the rest of the real economy, and talent is displaced from real production, as symbolized by all of the nuclear physicists on prop trading desks. Viewed from the perspective of the long-term well-being of the whole economy, the drastic expansion of the U.S. financial system as a percentage of total GDP in the last 20 years has been a drain on the health and cost structure of the balance of the real economy. To illustrate this point, in 1965 the financial sector of the economy took up 3% of the GDP pie. The 1960s were probably the high water mark (or one of them) of America’s capitalism. They clearly had adequate financial tools. Innovation could obviously have occurred continuously in all aspects of finance, without necessarily moving its share of the economy materially over 3%. Yet by 2007 the share had risen to 7.5% of GDP!

The financial world was reaching into the GDP pie and taking an unnecessary extra 4%. Every year! This extra rent is enough to lower the savings and investment potential of the rest of the economy. And it shows. As mentioned earlier, the growth rate of the GDP had been 3.5% a year for a hundred years. It had proven to be remarkably robust. Even the Great Depression bounced off it, and soon GDP growth was back on the original trend as if the Depression had never occurred. But after 1965, the growth of the non-financial slice, formerly 3.4%, slowed to 3.2%. After 1982 it dropped to 3.1% and after 2000 fell to well under 3%, all measured to the end of 2007, before the recent troubles. These are big declines. It is as if a runner has a growing and already heavy blood sucker on him that is, not surprisingly, slowing him down. In the short term, I realize that job creation in the financial industry looked like a growth driver, as did the surge in financial profits (which we now

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realize were ludicrously overstated). But in the long term, like a sugar high, this stimulus was temporary and unhealthy.

The financial system was growing because it could. The more complex and confusing new financial instruments became the more “help” ordinary citizens needed from the experts. The agents’ interests were totally unaligned with the principle/clients’ interests. This makes a mockery of “rational expectations” and the Efficient Market Hypothesis, which assumes (totally unproven, as usual) equivalent and perfect knowledge on both sides of all transactions. At the extreme, this great advantage in knowledge and information held by the financial agents has the agents receiving all the rewards, according to the recent work 3 by my former partner, Paul Woolley, and his colleagues at the Woolley Centre for the Study of Capital Market Dysfunctionality. (With a great name like that their job is half done before they start.)

The second problem, right on the heels of the too-big-and complicated issue, is that of inadequate public oversight. Even with existing institutions, we would have avoided most of the recent pain, borne by taxpayers, if we had had better public leadership. Yes, the public bodies had flaws, but the individuals running the shop had far bigger flaws. Greenspan, with arguably the most important job in the world, simply did not believe in interfering with capitalism at all. His regulatory colleagues such as Bernanke and Geithner fell into line without any challenges. And Congress, strongly influenced by the financial industry, or merely misguided, or often both, facilitated the approach that capitalism in general and banking in particular would do just fine if left entirely alone. It was a very expensive error. Does anyone think we would have run off the cliff with even one change – Volcker at the Fed? I, for one, am confident that we would have done far less badly.

Behind this weakness in the recent cast of characters is a systemic (suddenly the trendiest word in the English language) weakness in our method of job selection. How can Greenspan, with his long-established record of failure as a professional economist, have resurfaced as the Fed boss? With no record of success in any important job, he gets one of the world’s two most important jobs! Now we have to decide how much more decision- making power to give to the Fed – an institution with a 25-year proven record of failure. How can we separate the logical neatness of institutional design from our recent proven inability to pick effective, principled leaders with strong backbones?

It is a conundrum: too many regulatory agencies and you have too many opportunities for financial interests to shop around for regulatory bargains and to find and exploit the ambiguous seams between them. Too few agencies and we run the risk of my worst nightmare: waking up and finding Alan Greenspan with twice the authority!

At the least we must recognize the improbability of acquiring great leaders and that our financial system must be simple and robust enough to withstand the worst efforts from time to time of poor or even bad leadership. A simpler, more manageable financial system is much more than a luxury. Without it we shall surely fail again. And it looks as if we are bound and determined to bend once again to the will (and the money) of the financial lobby, which is encouraged by the unexpected conservatism of the current administration’s “Teflon” men. They seem terrified to make any substantial changes. And the one person with the character to make tough changes – Paul Volker – is window dressing, exactly as I suggested in January. A sad, wasted opportunity!

Summary

Yes, this was a profound failure of our financial system.

The public leadership was inadequate, especially in dealing with unexpected events that often, like the housing bubble breaking, should have been expected.

Of course, we should make a more determined effort to do a more effective job of leadership selection. But excellence in leadership will often be elusive.

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Equally obvious, we could make a hundred improvements to the lifeboats. Most would be modest beneficial improvements, but in the long run they would be almost completely irrelevant and, worse, they might kid us into thinking we were doing something useful!

But all of the above points fail to recognize the main problem: the system has become too big and complicated for even much-improved leaders to handle. Why should we be confident that we will find such improved leaders? For, even in an administration directed to “change,” Obama and his advisors fell back on the same cast of characters who allowed, even facilitated, the development of the current crisis. Reappointing Bernanke! What a wasted opportunity to get a “son of Volker” type. (Or should that be “grandson of Volker?”)

The size of the financial system continues to grow and shows every sign of being out of control. As it grows, it becomes a bigger drain on the rest of the economy and slows it down.

The only long-term hope of avoiding major recurrent crises is to make our financial system simpler, the units small enough that they can be allowed to fail, and, above all, to remove the intrinsically conflicted and dangerously risk-seeking hedge fund heart from the banking system. The rest is window dressing and wishful thinking.

The concept of rational expectations – the belief in the natural efficiency of capitalism – is wrong, and is the root cause of our problems. Hyman Minsky, on the other hand, was right; he argued that the natural outcome of ordinary people interacting is to make occasional financial crises “well nigh inevitable.” Crises are desperately hard to avoid. We must give ourselves a chance by making the job of dealing with them much, much easier. All in all we are likely to have learned little, or rather to act, through lack of character, as if we have learned nothing. In doing so we are probably condemning ourselves to another serious financial crisis in the not too- distant future.

Footnotes:

1 Erratum: Last quarter I cast mild aspersions on Finanz und Wirtschaft by suggesting that I had not precisely

said that the S&P would scoot rapidly up to 1100; I remembered it more as between 1000 to 1100. Never mess with a Swiss journalist: this one duly pointed out that his tape of April 1 confirmed his accuracy. Either way, here we are, more or less (at 1098 on October 19).

2 Andrew Mellon, Secretary of the Treasury, 1931.

3 Biais, Bruno; Rochet, Jean-Charles; and Woolley, Paul. Rents, Learning and Risk in the Financial Sector and other Innovative Industries. September, 2009. Working Paper Series 2009, The Paul Woolley Centre for the Study of Capital Market Dysfunctionality.

http://www.lse.ac.uk/collections/paulWoolleyCentre/news/RentsLearningAndRisk.htm

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Charleston October Snapshot

Charleston October Snapshot 20 C

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Real Estate Tidbits From a national perspective houses still aren't affordable based on historical price/income ratios. I wonder if “cash for homes” has anything to do with this chart. Hmmmm.

based on historical price/income ratios. I wonder if “cash for homes” has anything to do with

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Will the seasonal downturn take home prices down again?

Will the seasonal downturn take home prices down again? Moody’s Investors Service said it’s planning a

Moody’s Investors Service said it’s planning a review of U.S. home-loan securities that will likely lead to another round of rating changes based on a new view that property prices won’t bottom until next year’s third quarter.

The firm will boost its loss projections by “significant” amounts for prime-jumbo, Alt-A, option adjustable-rate and sub prime mortgages backing bonds issued between 2005 and 2008, also after seeing higher losses per

foreclosure than expected company said.

Recent data showing rising home prices doesn’t prove the slump is over, the

“The overhang of impending foreclosures and the continued rise in unemployment rates will impact home prices negatively in the coming months,” New York-based Moody’s said.

Source:Bloomberg

http://www.bloomberg.com/apps/news?pid=20601087&sid=a35NB2J0hkHw

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Housing Prices Could Keep Falling For Years?

http://www.dailyfinance.com/2009/10/21/housing-prices-forecast-to-fall-in-2010-and-could-keep-fallin/print/

http://www.dailyfinance.com/2009/10/21/housing-prices-forecast-to-fall-in-2010-and-could-keep-fallin/print/ Risk 23 C

Risk

http://www.dailyfinance.com/2009/10/21/housing-prices-forecast-to-fall-in-2010-and-could-keep-fallin/print/ Risk 23 C

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Below is a forecast from a firm called Real Estate Economics. They provide real estate research for multiple MSAs all over the U.S. I do not agree with all of their forecast but still believe it is a very good report that will give all of you some excellent insight from a different perspective on what to possibly expect over the next couple of years.

NATIONAL ECONOMIC AND HOUSING TRENDS AND 5-YEAR FORECASTS

Employment Trends and Forecasts

The main long-term foundational driver in terms of housing sales volume and price support is the nation’s employment base. The following table presents historical trends and a five year forecast in terms of employment and unemployment levels for the nation:

TOTAL NONFARM JOBS

UNITED STATES

OCTOBER 2009

 

Civilian Labor Force

Civilian Employment

 

Civilian

Total Non-Farm

 

Year

Total Jobs

12 Month Change

Total Jobs

12 Month Change in

Jobless Rate

Total Jobs

12 Month Change

1990 127,105,837

-

-

119,975,590

-

-

5.6% 109,486,583

-

-

1991 127,876,142

770,305

0.6% 119,132,052

-843,538

-0.7%

6.8%

108,374,500 -1,112,083 -1.0% 108,726,167 351,667 0.3%

1992 129,854,189

1,978,047

1.5% 120,095,180

963,128

0.8%

7.5%

1993 131,132,614

1,278,425

1.0% 122,052,557

1,957,377

1.6%

6.9% 110,843,750 2,117,583 1.9% 6.1% 114,290,500 3,446,750 3.1%

1994 133,173,236

2,040,621

1.6% 125,033,789

2,981,231

2.4%

1995 134,775,461

1,602,225

1.2% 127,200,126

2,166,337

1.7%

5.6% 117,297,583 3,007,083 2.6% 5.4% 119,708,000 2,410,417 2.1% 5.0% 122,776,417 3,068,417 2.6% 4.5% 125,929,667 3,153,250 2.6% 4.2% 128,993,000 3,063,333 2.4% 4.0% 131,784,833 2,791,833 2.2%

1996 136,728,912

1,953,452

1.4% 129,306,456

2,106,330

1.7%

1997 139,091,461

2,362,549

1.7% 132,176,514

2,870,058

2.2%

1998 140,735,712

1,644,251

1.2% 134,351,292

2,174,778

1.6%

1999 142,386,273

1,650,561

1.2% 136,356,857

2,005,565

1.5%

2000 143,941,312

1,555,038

1.1% 138,175,815

1,818,958

1.3%

2001 145,233,946

1,292,635

0.9% 138,337,066

161,251

0.1%

4.7%

131,825,667 40,833 0.0%

2002 146,437,709 1,203,763 0.8% 137,949,849 -387,218 -0.3% 5.8% 130,341,000 -1,484,667 -1.1%

2003 147,191,379 753,670 0.5% 138,381,556 431,708 0.3% 6.0% 129,999,083 -341,917 -0.3%

2004 148,171,228 979,849 0.7% 139,985,362 1,603,805 1.2% 5.5% 131,434,917 1,435,833 1.1%

2005 149,935,263 1,764,035 1.2% 142,298,978 2,313,616 1.7%

5.1% 133,702,833 2,267,917 1.7%

2006 150,310,245 374,982 0.3% 143,364,438 1,065,460 0.7% 4.6% 136,086,417 2,383,583 1.8%

2007 151,900,798 1,590,554 1.1% 144,878,528 1,514,090 1.1%

4.6% 137,598,417 1,512,000 1.1%

2008 153,476,399 1,575,600 1.0% 144,591,910 -286,618 -0.2% 5.8% 137,065,500 -532,917 -0.4%

2009est 152,918,970

-557,428

-0.4% 139,736,589 -4,855,320

-3.4%

9.4%

132,183,950 -4,881,550

-3.6%

2010prj 152,058,746 -860,225 -0.6% 138,651,708 -1,084,881 -0.8% 9.7% 131,157,742 -1,026,208 -0.8%

2011prj 151,549,055 2012prj 151,346,895

-509,690

-0.3% 139,416,192

764,483

0.6%

8.7%

131,881,175 723,433 0.6%

-202,160

-0.1% 140,922,533

1,506,342

1.1%

7.4% 133,306,408 1,425,233 1.1%

2013prj 152,150,833 803,938 0.5% 143,150,067 2,227,533 1.6% 6.3% 135,413,842 2,107,433 1.6%

2014prj 153,938,676 1,787,843 1.2% 146,128,825 2,978,758 2.1%

5.3% 138,231,925 2,818,083 2.1%

Source: Bureau of Labor Statistics; Real Estate Economics www.realestateeconomics.com

Patterns in total non-farm jobs in the nation are shown graphically as follows:

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UNITED STATES

Total Non-Farm

150,000,000 5-Year Forecast 140,000,000 130,000,000 120,000,000 110,000,000 100,000,000 90,000,000 80,000,000
150,000,000
5-Year Forecast
140,000,000
130,000,000
120,000,000
110,000,000
100,000,000
90,000,000
80,000,000
70,000,000
60,000,000
1990
109,486,583
1991
108,374,500
1992
1993
108,726,167
110,843,750
1994
1995
114,290,500
117,297,583
1996
119,708,000
1997
1998
122,776,417
125,929,667
1999
2000
128,993,000
131,784,833
2001
131,825,667
2002
2003
130,341,000
129,999,083
2004
2005
131,434,917
133,702,833
2006
2007
136,086,417
137,598,417
2008
2009est
137,065,500
132,183,950
2010prj
131,157,742
2011prj
131,881,175
2012prj
133,306,408
2013prj
135,413,842
2014prj
138,231,925

Twelve month changes in the total non-farm job base are shown in the chart below:

UNITED STATES

Total Non-Farm 12-Month Change

6,000,000

4,000,000

2,000,000

0

-2,000,000

-4,000,000

-6,000,000

5-Year Forecast 1990 0 1991 -1,112,083 1992 1993 351,667 2,117,583 1994 1995 3,446,750 3,007,083 1996
5-Year
Forecast
1990
0
1991
-1,112,083
1992
1993
351,667
2,117,583
1994
1995
3,446,750
3,007,083
1996
2,410,417
1997
1998
3,068,417
3,153,250
1999
2000
3,063,333
2,791,833
2001
40,833
2002
2003
-1,484,667
-341,917
2004
2005
1,435,833
2,267,917
2006
2007
2,383,583
1,512,000
2008
2009est
-532,917
-4,881,550
2010prj
-1,026,208
2011prj
723,433
2012prj
1,425,233
2013prj
2,107,433
2014prj
2,818,083

As shown, compounded by a financial crisis, the nation is forecast to lose 4,881,550 non-farm jobs during Year 2009 – a 3.6% loss of the total non-farm job base, or the biggest loss in decades. During Year 2010, another

1,026,208 jobs are forecast to be lost.

Thereafter, the impact from the national stimulus package will

increasingly be felt, and combined with improved financial markets, should lead the national economic recovery towards statewide economic expansion. By Year 2014, a healthy 2.1% growth rate is forecast for non-farm jobs nationally.

Patterns in unemployment are shown below:

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UNITED STATES

Civilian Unemployment

12%

10%

8%

6%

4%

2%

0%

5-Year Forecast 1990 5.6% 1991 6.8% 1992 1993 7.5% 6.9% 1994 1995 6.1% 5.6% 1996
5-Year Forecast
1990
5.6%
1991
6.8%
1992
1993
7.5%
6.9%
1994
1995
6.1%
5.6%
1996
5.4%
1997
1998
5.0%
4.5%
1999
2000
4.2%
4.0%
2001
4.7%
2002
2003
5.8%
6.0%
2004
2005
5.5%
5.1%
2006
2007
4.6%
4.6%
2008
2009est
5.8%
9.4%
2010prj
9.7%
2011prj
8.7%
2012prj
7.4%
2013prj
6.3%
2014prj
5.3%

After reaching historic levels estimated at 9.4% unemployment in 2009, it is forecast to peak at 9.7% in 2010 before gradually receding toward more normal levels thereafter. Several states with budget woes have intensified high unemployment levels.

Housing Construction Trends and Forecasts

Levels of housing construction in the Nation closely correlate with residential permit activity. Builders cut back sharply on construction after the housing bubble burst, causing the severe decline in permit activity in 2008. Residential permit activity is anticipated to drop to historic lows in 2009, and remain low through 2012, as shown in the chart below:

ANNUAL RESIDENTIAL PERMIT ACTIVITY

UNITED STATES

OCTOBER 2009

2014prj 2013prj 2012prj 2011prj 2010prj 2009est 2008 2007 2006 2005 2004 2003 2002 2001 2,500,000
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2005
2004
2003
2002
2001
2,500,000
5-Year Forecast
2000
1999
2,000,000
1998
1997
1996
1,500,000
1,000,000
1995
1994
500,000
1993
1992
1991
0
1990
Single Family
Multi-Family
Total

As shown, permit activity is at extremely depressed levels and will likely remain anemic for the next 3 years before gradually increasing to improved (but still low) levels by Year 2013.

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Corresponding trends in the overall housing stock are projected in the following chart:

TOTAL HOUSING SUPPLY UNITED STATES OCTOBER 2009

140,000,000

130,000,000

120,000,000

110,000,000

100,000,000

90,000,000

80,000,000

5-Year Forecast 2014prj 2013prj 2012prj 2011prj 2010prj 2009est 2008 2007 2006 2005 2004 2003 2002
5-Year Forecast
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
102,923,868
104,321,464
105,447,251
106,680,317
108,037,322
109,570,887
111,112,932
112,723,391
114,366,967
116,186,205
117,913,834
119,088,280
120,255,564
121,489,806
122,848,672
124,345,266
125,862,386
127,156,890
128,119,015
128,771,047
129,185,666
129,510,612
129,880,257
130,358,454
131,054,601

Gradual incremental growth in the nation’s housing stock is projected due to the recessionary impact on limited funding and limited feasibility for new home development. Incremental increases in housing stock will be relatively small – far lower than historical patterns:

12-MONTH CHANGE IN TOTAL HOUSING SUPPLY

UNITED STATES

OCTOBER 2009

2014prj 2013prj 2012prj 2011prj 2010prj 2009est 2008 2007 2006 2,000,000 5-Year Forecast 1,800,000 2005 2004
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2,000,000
5-Year Forecast
1,800,000
2005
2004
1,600,000
1,400,000
1,200,000
2003
2002
2001
1,000,000
800,000
600,000
2000
1999
400,000
200,000
1998
1997
1996
0
1995
1994
1993
1992
1991
1,397,596
1,125,786
1,233,066
1,357,006
1,533,565
1,542,045
1,610,459
1,643,576
1,819,238
1,727,629
1,174,447
1,167,283
1,234,242
1,358,866
1,496,594
1,517,120
1,294,504
962,125
652,032
414,618
324,946
369,644
478,197
696,147

Housing Price Trends and Forecasts

The following table presents historical and forecast changes in the median price of single family homes in the nation:

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MEDIAN HOME PRICES UNITED STATES

OCTOBER 2009

Time

Median

12-Month Change

Period

(Single-Family)

#

%

1990

$97,017

-

-

1995

$116,492

$3,683

3.3%

2000

$146,517

$5,850

4.2%

2001

$155,483

$8,967

6.1%

2002

$167,042

$11,558

7.4%

2003

$179,325

$12,283

7.4%

2004

$194,208

$14,883

8.3%

2005

$219,017

$24,808

12.8%

2006

$221,583

$2,567

1.2%

2007

$214,150

($7,433)

-3.4%

2008

$193,375

($20,775)

-9.7%

2009est

$174,834

($18,541)

-9.6%

2010prj

$176,365

$1,531

0.9%

2011prj

$180,108

$3,744

2.1%

2012prj

$185,042

$4,933

2.7%

2013prj

$191,600

$6,558

3.5%

2014prj

$200,083

$8,483

4.4%

Source: National Association of Realtors; Dataquick; Real Estate Economics

www.realestateeconomics.com

Though the above table reflects median prices for single-family homes only, the percentage changes will likely be similar for condominium product.

As shown, declines in housing values during 2008 were harsh, with less severe drops estimated in 2009 (mostly occurring in the 1 st half) with stabilization projected during the 2 nd half of the year. By 2010, prices will flatten out with demand pressures driving a slight 1.8% increase.

These pricing trends and forecasts in median prices for single family homes in the nation are shown graphically below:

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MEDIAN HOME PRICES UNITED STATES OCTOBER 2009

$240,000 5-Year Forecast $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 2014prj
$240,000
5-Year Forecast
$220,000
$200,000
$180,000
$160,000
$140,000
$120,000
$100,000
$80,000
$60,000
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
$97,017
$102,500
$105,017
$108,742
$112,808
$116,492
$122,267
$128,650
$135,467
$140,667
$146,517
$155,483
$167,042
$179,325
$194,208
$219,017
$221,583
$214,150
$193,375
$174,834
$176,365
$180,108
$185,042
$191,600
$200,083

As shown, declines in housing values during 2008 and projected for 2009 are substantial. The median home price has fallen 21% from its peak in 2006 to a level similar to the median price in 2003. It should be noted that most of the decline associated with the 2009 forecast mostly occurred during the 1 st half of the year, and further losses in housing prices will be minimal from the extremely low level already defined during the 1 st half of 2009.

The median price is expected to bottom out in 2009, and remain relatively flat in 2010, after which mild price appreciation patterns will likely occur, building momentum as the economy improves and distressed inventory is absorbed. By 2014, the median home price is forecast to increase a healthy 4.4%. Despite this increase, the resultant forecast median price for 2014 will remain well below the peak unsupportable level achieved during

2006.

Mortgage Rate Trends and Forecast

The chart below presents trends and forecasts for 30 year fixed mortgage rates:

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30-YEAR FIXED RATE MORTGAGES NATIONAL AVERAGES SEPTEMBER 2009

11% 5-Year Forecast 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 2014prj
11%
5-Year Forecast
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
10.1%
9.2%
8.4%
7.3%
8.4%
8.0%
7.8%
7.6%
6.9%
7.4%
8.1%
7.0%
6.6%
5.8%
5.8%
5.9%
6.4%
6.3%
6.0%
5.1%
5.2%
5.5%
5.9%
6.4%
7.2%

As shown, Years 2009 and 2010 will be the lowest years in terms of mortgage rates in over two decades. The super low home loan rates have been made possible by the Federal Reserve’s extraordinary efforts to prop up the housing market and the overall economy in the wake of the global financial crisis.

A window of opportunity exists to refinance or purchase a home at historically low rates, allowing for much more relatively affordable housing costs for most buyers. By 2011 mortgage rates are likely to increase as economic growth increasingly stimulates inflationary pressures, and as the world demands higher payments to service the nation’s enormous debt load.

Household Income Trends and Forecasts

The following table presents trends in median household incomes for the nation:

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MEDIAN HOUSEHOLD INCOMES UNITED STATES OCTOBER 2009

$70,000 5-Year Forecast $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 2014prj 2013prj 2012prj 2011prj
$70,000
5-Year Forecast
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
2014prj
2013prj
2012prj
2011prj
2010prj
2009est
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
$31,058
$31,885
$32,844
$33,872
$34,940
$35,757
$37,122
$38,860
$40,405
$41,844
$43,184
$44,000
$44,821
$45,358
$46,051
$47,030
$48,655
$50,125
$51,251
$51,552
$51,930
$52,573
$53,489
$54,691
$56,195

As shown, increases in median household incomes are likely to be marginal during Years 2009 and 2010 – a reflection of the current economic downturn and nationwide budget deficit. Thereafter, income growth is likely to begin to normalize, reaching a 2.7% gain by Year 2014.

Overall trends and changes in household incomes by income range during the next 5 years are shown in the chart below:

FORECAST HOUSEHOLD INCOME CHANGES FROM 2009 TO 2014 UNITED STATES

4,000,000 3,000,000 2,000,000 1,000,000 -1,000,000 -2,000,000 -3,000,000 5 Yr. Change in No. of Households
4,000,000
3,000,000
2,000,000
1,000,000
-1,000,000
-2,000,000
-3,000,000
5 Yr. Change in No. of Households

Less than $50k

$50k - $100k

$100k - $150k

$150k - $200k

Houshold Income Range

$200k - $250k

$250k +

Source: Real Estate Economics; Claritas; Dataquick; Census Bureau; Bureau of Labor.

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As shown, the number of households making between $50,000 and $150,000 is likely to increase dramatically during the next five years as the population matures and as economic growth resumes.

Demographic Trends and Forecasts

The distribution of the population in the nation by age bracket is shown in the following chart:

POPULATION DISTRIBUTION BY AGE UNITED STATES

50,000,000 45,000,000 40,000,000 35,000,000 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 -
50,000,000
45,000,000
40,000,000
35,000,000
30,000,000
25,000,000
20,000,000
15,000,000
10,000,000
5,000,000
-
Age < 5
Age 5
Age 15
Age 25
Age 35
Age 45
Age 55
Age 65
Age 75
Age 85+
to 14
to 24
to 34
to 44
to 54
to 64
to 74
to 84
2000 Census
Yr. 2009 Estimates
Yr. 2014 Forecasts

Source: Real Estate Economics; Claritas; Dataquick; Census Bureau; Bureau of Labor.

The population distribution by age compares estimates for 2009 and forecasts for 2014 with Census data from the year 2000.

Changes in the population between 2009 and 2014 are more clearly shown in the following chart:

FORECAST POPULATION CHANGES FROM 2009 TO 2014 UNITED STATES

Age 85+ Age 75-84 Age 65-74 Age 55-64 Age 45-54 Age 35-44 6,000,000 5,000,000 Age
Age 85+
Age 75-84
Age 65-74
Age 55-64
Age 45-54
Age 35-44
6,000,000
5,000,000
Age 25-34
4,000,000
3,000,000
Age 15-24
2,000,000
1,000,000
Age 5-14
0
-1,000,000
Age < 5
-2,000,000
5-Year Population Change

Source: Real Estate Economics; Claritas; Dataquick; Census Bureau; Bureau of Labor.

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As shown, except for a population loss in the 35 to 44 years age bracket, relatively modest population gains are forecast among all age brackets except for move-down householders between 55 and 74 years of age. For age brackets between 55 years and 74 years, population growth is especially intense, and will greatly impact the overall choices available in the housing market.

As a result, move-down and age targeted/qualified housing in various forms are likely to perform relatively well

once economic growth resumes.

boomers now account for one-fifth of the national population. The mature market is anticipated to perform very

well in the next cycle, as is moderately priced conventional housing, while select move-up price ranges of the conventional housing market may remain relatively sluggish.

This influx of buyers into the mature housing market is significant since baby

NATIONAL HOUSING SUPPLY/DEMAND AND OVER/UNDER VALUATION PATTERNS AND 5- YEAR FORECASTS

Each month, Real Estate Economics updates our database to reflect the most recent changes in national

employment, housing supply, housing prices, mortgage rates and all other major factors that directly influence

housing demand and supply.

forecasts housing supply and demand patterns and price appreciation/depreciation for the next five years. This report presents our most recent modeled conclusions.

All of our economic and housing market data flow into a predictive model that

Housing Supply and Demand Trends and Forecasts

The following housing demand model generated from our economic database, presents our housing supply/demand estimates and forecasts for the United States:

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HOUSING DEMAND/SUPPLY PATTERNS UNITED STATES OCTOBER 2009

 

Total

Housing

Housing

Market is Under/ (Over) Supplied

Year

Jobs

Supply

Demand

1990

109,486,583

102,923,868

101,806,967

(1,116,902)

(1.1%) Overbuilt

1991

108,374,500

104,321,464

100,851,641

(3,469,824)

(3.3%) Overbuilt

1992

108,726,167

105,447,251

101,258,343

(4,188,908)

(4.0%) Overbuilt

1993

110,843,750

106,680,317

103,311,425

(3,368,892)

(3.2%) Overbuilt

1994

114,290,500

108,037,322

106,607,491

(1,429,832)

(1.3%) Overbuilt

1995

117,297,583

109,570,887

109,498,096

(72,792)

(0.1%) Overbuilt

1996

119,708,000

111,112,932

111,836,194

723,262

0.7% Underbuilt

1997

122,776,417

112,723,391

114,792,982

2,069,591

1.8% Underbuilt

1998

125,929,667

114,366,967

117,833,714

3,466,747

3.0% Underbuilt

1999

128,993,000

116,186,205

120,795,063

4,608,859

4.0% Underbuilt

2000

131,784,833

117,913,834

123,506,743

5,592,910

4.7% Underbuilt

2001

131,825,667

119,088,280

123,642,167

4,553,886

3.8% Underbuilt

2002

130,341,000

120,255,564

122,346,161

2,090,598

1.7% Underbuilt

2003

129,999,083

121,489,806

122,121,539

631,733

0.5% Underbuilt

2004

131,434,917

122,848,672

123,568,224

719,552

0.6% Underbuilt

2005

133,702,833

124,345,266

125,799,826

1,454,559

1.2% Underbuilt

2006

136,086,417

125,862,386

128,143,749

2,281,363

1.8% Underbuilt

2007

137,598,417

127,156,890

129,670,018

2,513,128

2.0% Underbuilt

2008

137,065,500

128,119,015

129,270,151

1,151,136

0.9% Underbuilt

2009est

132,183,950

128,771,047

124,765,114

(4,005,933)

(3.1%) Overbuilt

2010prj

131,157,742

129,185,666

123,895,077

(5,290,589)

(4.1%) Overbuilt

2011prj

131,881,175

129,510,612

124,677,524

(4,833,088)

(3.7%) Overbuilt

2012prj

133,306,408

129,880,257

126,126,308

(3,753,949)

(2.9%) Overbuilt

2013prj

135,413,842

130,358,454

128,221,150

(2,137,304)

(1.6%) Overbuilt

2014prj

138,231,925

131,054,601

130,993,878

(60,723)

(0.0%) Overbuilt

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors

Real Estate Economics www.realestateeconomics.com

In general, the patterns of over supply and under supply are based on a comparison between a given year’s ratio between jobs and housing relative to the long-term trend. As shown, the table presents patterns in over-supply and under-supply of housing in the nation since 1990, with a forecast extending to 2014.

The model accurately measures significant levels of distressed inventory which are likely to peak during the next 24 months, followed thereafter by a trend toward under-supply, which is likely to first occur during 2014, with the market showing tightness as early as 2013. Under-supply is likely to be significant after 2014. These patterns are shown graphically in the chart below:

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Units Demand/Supplied

HOUSING DEMAND AND SUPPLY PATTERNS

UNITED STATES

140,000,000 5-Year Forecast 135,000,000 130,000,000 125,000,000 120,000,000 115,000,000 Jan 1- 4 p jr 110,000,000
140,000,000
5-Year Forecast
135,000,000
130,000,000
125,000,000
120,000,000
115,000,000
Jan 1- 4 p jr
110,000,000
Jan 1- 3 prj
Jan 1- 2 prj
aJ n-11 prj
Jan-10 p jr
105,000,000
100,000,000
95,000,000
Jan-09
90,000,000
Jan-08
Jan 0- 7
Jan 0- 6
Jan 0- 5
aJ n 0- 4
aJ n-03
Supply of Housing
Demand for Housing*
Jan-02
Jan-01
Jan-00
Jan 9- 9
Jan 9- 8
Jan 9- 7
aJ n 9- 6
aJ n-95
Jan-94
Jan-93
Jan-92
Jan 9- 1
Jan 9- 0

* Over/Under supply measures based on current jobs-to-housing relationship relative to long-term relationship between jobs and housing.

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

As shown, demand and supply estimates represent the total number of houses demanded and supplied in the United States. The current year reflects over-supply which will likely worsen during the next twelve months before improving, then reaching equilibrium during late 2013. Thereafter, another cycle of under-supply is likely to form as the economy continues to expand in an atmosphere of relatively low housing supply.

The chart below presents these patterns in over and under-supply by measuring differences between overall demand and overall supply:

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HOUSING (OVER)/UNDER SUPPLY PATTERNS

UNITED STATES

8,000,000 5-Year Forecast 6,000,000 4,000,000 2,000,000 - (2,000,000) Jan-14 prj (4,000,000) Jan-13 prj
8,000,000
5-Year
Forecast
6,000,000
4,000,000
2,000,000
-
(2,000,000)
Jan-14 prj
(4,000,000)
Jan-13 prj
(6,000,000)
Jan-12 prj
J
na -11 prj
(8,000,000)
Jan-10 prj
Jan-09
Jan-08
J
na -07
Jan-06
Jan-05
Jan-04
J
na -03
Jan-02
Jan-01
Jan-00
J
na -99
J
na -98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
J na -90
OVER BUILT
UNDER BUILT

* Over/Under supply measures based on current jobs-to-housing relationship relative to long-term relationship between jobs and housing.

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

As shown, oversupply (mainly caused by over building during the past several years and high levels of distressed housing) will cause continued (but more conservative) depreciation in the current year, followed by relatively flat pricing in Year 2010, then low rates of price appreciation beginning by 2011. Periods of oversupply should be followed by increasing levels of undersupply as the economy begins to expand and as incremental housing supply remains very low.

It should be noted that patterns in over-supply or under-supply do not fully describe the health of the overall housing market. Absorption of housing can be strong in an atmosphere of over supply and under valuation. In order to more fully understand market health, patterns in over- and under-valuation must be understood. These patterns are presented in the next section.

Housing Over/Under Valuation Trends and Forecasts

Historical trends and a five year forecast in terms of overall housing over-or-under-valuation for the United States is shown below:

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HOUSING OVER/UNDER VALUATION PATTERNS UNITED STATES OCTOBER 2009

 

Median

Equilibrium

30-Yr.

Ann. Mtg.

Equil

Median

Market is Under/ (Over) Valued

Year

Home Price

Home Price

Mtg. Rate

Cost

Mtg.Cost

HH Income

1990

$97,017

$86,678

10.13%

$8,263

$7,380

$31,058

($10,339)

(10.7%) Overvalued

1991

$102,500

$95,882

9.25%

$8,095

$7,563

$31,885

($6,618)

(6.5%) Overvalued

1992

$105,017

$106,426

8.40%

$7,681

$7,777

$32,844

$1,410

1.3% Undervalued

1993

$108,742

$121,403

7.33%

$7,178

$8,006

$33,872

$12,661

11.6% Undervalued

1994

$112,808

$113,501

8.36%

$8,217

$8,243

$34,940

$693

0.6% Undervalued

1995

$116,492

$120,388

7.96%

$8,171

$8,421

$35,757

$3,897

3.3% Undervalued

1996

$122,267

$126,335

7.81%

$8,454

$8,726

$37,122

$4,069

3.3% Undervalued

1997

$128,650

$134,719

7.60%

$8,717

$9,118

$38,860

$6,069

4.7% Undervalued

1998

$135,467

$149,061

6.94%

$8,603

$9,464

$40,405

$13,595

10.0% Undervalued

1999

$140,667

$146,917

7.43%

$9,377

$9,783

$41,844

$6,250

4.4% Undervalued

2000

$146,517

$142,327

8.06%

$10,383

$10,078

$43,184

($4,190)

(2.9%) Overvalued

2001

$155,483

$160,971

6.97%

$9,903

$10,250

$44,000

$5,488

3.5% Undervalued

2002

$167,042

$170,803

6.57%

$10,207

$10,422

$44,821

$3,761

2.3% Undervalued

2003

$179,325

$186,054

5.85%

$10,152

$10,527

$45,358

$6,729

3.8% Undervalued

2004

$194,208

$188,627

5.84%

$10,990

$10,669

$46,051

($5,581)

(2.9%) Overvalued

2005

$219,017

$191,766

5.87%

$12,425

$10,876

$47,030

($27,251)

(12.4%) Overvalued

2006

$221,583

$186,876

6.41%

$13,321

$11,231

$48,655

($34,707)

(15.7%) Overvalued

2007

$214,150

$193,539

6.34%

$12,782

$11,548

$50,125

($20,611)

(9.6%) Overvalued

2008

$193,375

$204,019

6.04%

$11,180

$11,786

$51,251

$10,644

5.5% Undervalued

2009est

$174,834

$226,837

5.11%

$9,123

$11,833

$51,552

$52,004

29.7% Undervalued

2010prj

$176,365

$226,368

5.18%

$9,272

$11,898

$51,930

$50,003

28.4% Undervalued

2011prj

$180,108

$221,769

5.45%

$9,767

$12,023

$52,573

$41,661

23.1% Undervalued

2012prj

$185,042

$215,439

5.86%

$10,489

$12,210

$53,489

$30,397

16.4% Undervalued

2013prj

$191,600

$207,233

6.42%

$11,524

$12,461

$54,691

$15,633

8.2% Undervalued

2014prj

$200,083

$196,993

7.16%

$12,984

$12,780

$56,195

($3,090)

(1.5%) Overvalued

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

As shown, historical and forecast median home prices are compared with our modeled estimates of supportable median home prices since 1990.

Similar to our over/under supply analysis presented in the previous section, differences between our modeled estimate of supportable median home prices and actual median home prices offer measures of over-valuation or under-valuation since 1990, with forecasts during the next five years.

These differences between supportable median home prices and actual median home prices are shown in the chart below:

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Median Housing Value

HOUSING VALUATION PATTERNS

UNITED STATES

$250,000 5-Year Forecast $225,000 $200,000 $175,000 $150,000 $125,000 Jan-14 prj $100,000 Jan-13 prj Jan-12 prj
$250,000
5-Year Forecast
$225,000
$200,000
$175,000
$150,000
$125,000
Jan-14 prj
$100,000
Jan-13 prj
Jan-12 prj
$75,000
Jan-11 prj
$50,000
Jan-10 prj
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Historical/Forecast Median Home Price Supportable Median Home Price*

Historical/Forecast Median Home Price

Historical/Forecast Median Home Price Supportable Median Home Price*

Supportable Median Home Price*

* Over/Under valuation based on value of housing (inclusive of mortgage rates) relative to long-term relationship between housing value & household incomes.

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

The blue curve shown in the chart above represents actual median home prices recorded since 1990, and projections through 2014. The green curve shows our modeled estimate of supportable housing values based on the relationship of mortgage costs (which incorporate mortgage rates) with household incomes relative to the long-term balance between costs and incomes. Periods where the actual median exceeds the supportable median reflect periods where the housing market is over valued. When the actual median falls below the supportable median, under valuation is evident.

These patterns in over- and under-valuation are shown more clearly below:

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VALUED UNDER VALUEDOVER

HOUSING (OVER)/UNDER VALUATION PATTERNS

UNITED STATES

$75,000

(OVER)/UNDER VALUATION PATTERNS UNITED STATES $75,000 $50,000 $25,000 $0 ($25,000) ($50,000) ($75,000) 5-Year

$50,000

$25,000

$0

($25,000)

($50,000)

UNITED STATES $75,000 $50,000 $25,000 $0 ($25,000) ($50,000) ($75,000) 5-Year Forecast aJ n- 41 p jr

($75,000)

5-Year Forecast aJ n- 41 p jr Jan- 31 p jr J na 1- 2
5-Year Forecast
aJ n- 41 p jr
Jan- 31 p jr
J
na 1- 2 prj
J
na 1- 1 prj
J
na 1- 0 rp j
aJ n 0- 9
aJ n- 80
Jan- 70
J
na 0- 6
J
na 0- 5
aJ n 0- 4
aJ n 30-
aJ n- 20
Jan- 10
J
na 0- 0
J
na 9- 9
J
na 9- 8
aJ n 79-
aJ n- 69
Jan- 59
J
na 9- 4
J
na 9- 3
J
na 9- 2
aJ n- 19
aJ n- 09

* Over/Under valuation based on value of housing (inclusive of mortgage rates) relative to long-term relationship between housing value & household incomes.

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

As shown, the model accurately reflected serious levels of over valuation which occurred from 2004 through 2007. Precipitous drops in price during 2007 and 2008, and continuing into 2009, have caused current levels of unprecedented under valuation, which have been magnified by historically low fixed mortgage rates. It must be stressed that these severe levels of under valuation, which are now apparent, reflect not only severe price drops during the past 24 months, but also historically low fixed mortgage rates. If rates jump, the unprecedented level of under valuation would disappear.

Given our forecasts for rising mortgage rates and eventual price appreciation, levels of under-valuation are likely to recede fairly gradually, with equilibrium and some modest over valuation forecast to appear in 2014.

These patterns suggest that the ideal time for housing and residential land purchases in the United States began early 2009 and should continue during the next 12 to 24 months. Thereafter, strong values will continue, but at a diminishing rate. Never in recent history have housing values been so strong in the nation – reflective of a severe recession, but even more reflective of the impact of extremely tight credit and artificially low mortgage rates. For those households who are secure in their jobs and who can purchase a home with a fixed rate mortgage, there may never be a better opportunity.

Overall Market Forecast

Our analysis of both housing supply and demand patterns, and housing over/under valuation is merged into a composite index that Real Estate Economics refers to as the Market Opportunity/Risk Index as presented in the exhibit at the end of this report. This index includes jobs-to-housing relationships and mortgage cost-to- income relationships as shown in the following chart taken from the exhibit:

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Jan 0- 3

Jan 9- 5

Jan 9- 7

Jul 0- 4

aJ n 0- 1

Jul 0- 1

Jan 0- 0

Jan 0- 6

Jul 9- 6

Jan 0- 5

Jan 9- 8

aJ n 1- 3 p jr

aJ n-14 p jr

Jul-13 p jr

1 Jul 9- 9

aJ n 9- 3 Jul 9- 2 Jan 9- 2

uJ l-16 p jr aJ n-16 p jr Jul 1- 5 p jr Jan 1- 5 prj uJ l 1- 4 prj

Jul 1- 2 p jr Jan 1- 2 prj uJ l 1- 1 prj aJ n-11 p jr Jul-10 p jr Jan 1- 0 p jr uJ l 0- 9 prj Jan 0- 9 uJ l-08 aJ n-08

uJ l 0- 6

uJ l 9- 4

aJ n-07

aJ n 0- 4

aJ n-02

Jul 0- 7

Jul-02

uJ l-05

uJ l-00

uJ l 9- 5

aJ n-94

aJ n 9- 6

uJ l 0- 3

Jul-93

uJ l-97

aJ n-99

uJ l 9- 8

RESIDENTIAL MARKET OPPORTUNITY/RISK INDEX

UNITED STATES

OCTOBER 2009

Composite O/R Index Jobs-to-Housing Index Mortgage Cost-to-Income Index Equilibrium 140.0 5-Year Forecast 130.0
Composite O/R Index
Jobs-to-Housing Index
Mortgage Cost-to-Income Index
Equilibrium
140.0
5-Year Forecast
130.0
120.0
110.0
100.0
150
150.0
90.0
140
140.0
130
130.0
80.0
120
120.0
110
110.0
70.0
100
100.0
90
90.0
80
80.0
uJ l-14 p jr
70
70.0
INDEX DATE
aJ n-14 p jr
60
60.0
Jul 1- 3 p jr
Jan 1- 3 prj
uJ l 1- 2 prj
aJ n-12 p jr
Jul-11 p jr
aJ n 1- 1 p jr
Jul 1- 0 p jr
Jan 1- 0 prj
uJ l 0- 9 prj
aJ n-09
Jul-08
Jan 0- 8
uJ l 0- 7
Jan 0- 7
uJ l-06
aJ n-06
Jul 05-
aJ n-05
uJ l 0- 4
Jan 0- 4
uJ l-03
Jan 0- 3
Jul 0- 2
aJ n 0- 2
uJ l 0- 1
Jan 0- 1
Jul-00
aJ n-00
Jul 9- 9
aJ n 9- 9
uJ l-98
Jan 9- 8
Jul 97-
aJ n-97
uJ l 9- 6
Jan 9- 6
uJ l-95
Jan 9- 5
Jul 9- 4
aJ n 9- 4
uJ l 9- 3
Jan 9- 3
uJ l 9- 2
aJ n-92
Jul-91
aJ n 9- 1
Jul 9- 0
Jan 9- 0
STRONGERWEAKER

50 50.0

aJ n 9- 1 Jul 9- 0 Jan 9- 0 STRONGERWEAKER 50 50.0 ESTIMATED DATE THE
aJ n 9- 1 Jul 9- 0 Jan 9- 0 STRONGERWEAKER 50 50.0 ESTIMATED DATE THE

ESTIMATED DATE THE INDEX IS FIRST MANIFEST IN THE MARKET

97.5

102.5

ESTIMATED DATE THE INDEX IS FIRST MANIFEST IN THE MARKET

Source: Bureau of Labor Statistics; Census Bureau; National Assoc. of Realtors; Real Estate Economics www.realestateeconomics.com

It must be stressed that the Opportunity/Risk Index tends to lead market changes by as much as 24 months. For example, as the composite index began to fall significantly below equilibrium in 2005, it correctly predicted market troubles which first became apparent by early 2006. The index formed a floor during 2006, translating to the worst part of the real estate cycle being felt during 2008. The index reached and began surpassing equilibrium early 2008, but the resultant market stability is not likely to be manifest until mid-2010.

Similarly, the high level that the index has currently reached during the 1 st half of 2009 will not likely be manifest in the market until the 1 st half of 2011. If relationships between this index and actual market manifestation holds true, overall market conditions should improve dramatically during 2011 from current levels. Prices will essentially remain flat in 2010, but demand pressures and mild appreciation will become increasingly apparent by 2011 as more households recognize the severe under valuation of housing throughout the nation, and as the economy resumes expansion.

Summary

With Federal Reserve Chairman Ben Bernanke’s recent announcement that the national recession is likely over, our key indicators outlined in this report suggest a prolonged weak economic recovery. Having suffered through some of the nation’s biggest downturns in labor and housing, recent rising unemployment and falling home prices have been less severe. Persistent weakness in the job market has increased unemployment to 9.4% with forecasts for it to peak during the middle of 2010. As a lagging indicator, rising unemployment will occur as the economy begins to build from its defined floor and job creation begins to gain momentum.

The national housing market clearly benefited by stimulus measures including an $8,000 federal first-time homebuyer tax credit and low mortgage interest rates, which made housing more affordable and served to lessen the severity of the downturn. Congress is facing pressure to extend the tax credit which is set to expire on November 30 - being uncertain about spending more money to prop up the housing market. While large price swings brought greater instability as the median price fell 21% from peak levels experienced in 2006, stability is expected by 2010 as prices bottom out. Once prices begin to stabilize, they will likely ‘ride the floor’ for a few quarters, rising a projected 0.9% next year.

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First time buyers and investors have provided much of the momentum in home sales this year, snapping up foreclosures and distressed properties. As distressed inventory continues to fall, market share will begin to swing back to the new home market if enhanced value is apparent and supply is made available. Housing permits will continue to fall, which will eventually help to bring supply into balance with demand.

Uncertainty exists regarding another potential wave of foreclosures. Despite reports of rising defaults, the next wave of foreclosure activity may likely be much less pronounced than the first wave due to the following:

Many Adjustable Rate Mortgages (ARMs) are resetting at lower interest rates,

Many ‘teaser rate’ ARMs have already gone into foreclosure, i.e., the 1 st wave was bigger than anticipated,

Many government and bank programs that are designed to reduce foreclosures are just beginning to be fully implemented,

Prices are dropping to levels that stimulate a sale, effectively pre-empting foreclosure,

The economic impact from the stimulus package has not been fully felt, with job creation reducing foreclosures.

The effect of a foreclosure surplus on prices will continue to wane, because values have already dropped to levels that stimulate strong demand for distressed properties. When distressed inventory is finally absorbed, the low level of new housing in the pipeline should put upward pressure on sales volume and price support due to limited competition. Historic under valuation will be followed by price appreciation once economic growth emerges, forecast to occur by 2011, setting the stage for significantly improved housing conditions as the economy begins to expand.

Source:www.realestateeconomics.com

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Disclaimer The research done to gather the data in The Charleston Market Report involves examining thousands of listings. With this much data inaccuracies will occur. Care is taken in gathering and processing the data and information within this report is deemed reliable. IT IS NOT GUARANTEED. The real estate market is cyclical and will have its ups and downs. Past performance cannot determine future performance. The purpose of the Charleston Market Report is to educate you on current and consistent market conditions by reporting leading market indicators with the support of traditional real estate data.

This information is offered with the understanding that the author is not engaged in rendering legal, tax or other professional services. If legal, tax or other expert assistance is required, the services of a competent professional are recommended. This is a personal newsletter reflecting the opinions of its author. It is not a production of my employer. Statements on this site do not represent the views or policies of anyone other than myself.

Investing in real estate is not a get-rich-quick scheme nor is there any guarantee you will make a profit. Every effort has been made to make this report as complete and accurate as possible. However, there may be mistakes. Therefore, this report should be used only as a general guide and not as the ultimate source for making money in real estate.

www.charlestonmarketreport.com